I am a Professor of Economics at Texas Christian University, where I have worked since 1987. My areas of specialty are international economics (particularly exchange rates), macroeconomics, history of economics, and contemporary schools of thought. During my time in Fort Worth, I have served as department chair, Executive Director of the International Confederation of Associations for Pluralism in Economics, a member of the board of directors of the Association for Evolutionary Economics, and a member of the editorial boards of the American Review of Political Economy, the Critique of Political Economy, the Encyclopedia of Political Economy, the Journal of Economics Issues, and the Social Science Journal. My research consists of over thirty refereed publications, two edited volumes, and one book (with another in process). I have also been lucky enough to win a couple of teaching awards.
In terms of my approach to this blog, I am a firm believer that economics can and must be made understandable to the general public, but that our discipline has done a very poor job in this regard. This is particularly true of macro issues, where people quite naturally assume that their personal experiences are analogous to those at the national scale. Very often, this is not the case, with the result that politicians and voters (and some economists) press for policies whose effects are quite the opposite of what was intended. That this is problematic has never been more evident than today. I also try to steer as clear of politics as possible. I want to explain how things work, not what you should believe.
I have been married to my wife, Melanie, for over twenty-five years, and we have twin daughters (who have just started college) and a dog named Rommel (who has not). My favorite pastimes are online computer gaming and reading about WWII history.

Why You Should Learn to Love the Deficit: Federal Budget Fallacies

I’ve made eleven contributions to Forbes.com so far, over half of which were aimed directly at correcting misconceptions regarding the debt and deficit. Nothing could be more foolish right now than policies that reduce government spending or increase taxes. We have nearly 14 million unemployed people in the United States, a number that undoubtedly underestimates the true magnitude of the problem since it ignores discouraged workers and the underemployed. Despite this, Messrs. Obama, Ryan, and Geithner tell us that we need to make sacrifices. Seriously? The American people already have, and what they are asking us to do will simply make it worse.

And so, I’m writing on this issue yet again. There won’t be anything new here, but I want to organize it in a slightly different manner. I’ll begin with a very general background, then offer a list of popular fallacies, and close with some pointers to more resources.

BACKDROP

Understanding the role of the federal budget requires knowing a little something about the macroeconomy. Most critical is the fact that the private sector is incapable of consistently generating sufficient demand to hire all those willing to work. This is in spite of being able to produce enough output for everyone to enjoy–in fact, it’s partly because of it. A detailed explanation is offered in this post, Why Recessions Happen, but for here suffice it to say that if 90 people can produce a sufficient volume of goods and services to satisfy 100 people, then why would the private sector hire all 100? It wouldn’t, and those without jobs must go without the output that we are nevertheless able to produce for them. The unemployed lack the income that would make the production of those extra goods and services profitable.

This is where the government can play a useful, indeed vital, role. They can supplement demand by employing the unemployed as soldiers, sailors, airmen, marines, teachers, firemen, police officers, etc. Because we started at a point of less-than-full capacity, private sector workers give up nothing, entrepreneurs earn extra profits, and it creates a series of non-market services (national defense, fire protection, education, etc.). It is truly a win-win situation, which is possible when we have idle resources. And the funds to finance these activities should come from deficit spending. There is no point in taxing away spending power from the private sector in order to create demand from the government. That’s self-defeating.

This is the essential role that only the government can play, for only it can create demand from thin air. There is no other alternative if we want capitalism to survive. Should we seek to limit government power? Absolutely, just as much as we should do so with those mega-corporations that are dominating the private sector. But a modern capitalist economy without public sector demand will fail.

POPULAR FALLACIES (in no particular order)

When the government spends in deficit, that means I am being taxed more: I’ve heard this one numerous times and it’s very obviously false–the fact that you are not being taxed to cover the spending is WHY it’s a deficit! If taxes were rising along with the spending, then it would be a balanced budget. Does it mean taxes may rise in the future? It shouldn’t. In fact, if the deficit does what it’s supposed to, then the economy grows and the deficit automatically shrinks (as tax revenues rise and government spending for unemployment and income assistance falls).

Cutting the deficit by reducing spending puts money in my pocket: This ignores the fact that a) you weren’t being taxed to finance the deficit in the first place (or it wouldn’t have been a deficit) and b) government spending is money in someone’s pocket. Thus, cutting the deficit by reducing spending removes money. This is true even if you are in the private sector, since those government employees bought groceries, paid rent, went to the mall, etc., etc. They earned income for you by buying what you sell.

You can’t spend your way out of a recession: Of course you can. We did it in the Great Depression, Reagan did it, and it’s what we should be doing right now (instead of bailing out the financial industry, wasting time with Quantitative Easing, and trying to balance the budget). Why this works should be obvious from the backdrop offered above. Businesses will regain confidence, consumers will spend, and banks will loan. So, yes, you can spend your way out of a recession because a recession is caused by lack of spending.

Cutting government spending frees up resources for the private sector to grow: It might do so if we were already at full employment and using all our productive capacity. However, in the midst of the worst recession since the Great Depression, this argument holds no water whatsoever. We have plenty of idle resources, the private sector is simply choosing not to employ them. There is no need to free up something that is already in excess supply. Nor is there some web of regulations and taxes that is preventing recovery. The past thirty years has been a continuous deregulation of our economy and effective tax rates as a low as they have been since before World War Two.

The debt has never been this large: The proper measure of the size of the debt is relative to the size of the economy. Gross Domestic Product is typically used as the gauge of the latter. Even the most extreme measures of where it stands today puts debt/GDP at less than 100%. It reached it peak during WWII, when it was around 120% of GDP. The 1950s were , incidentally, hardly a period of economic Armageddon.

We have largest debt in the world: According to the CIA Factbook, as of 2010 we ranked 37th. That put us behind the world average, Spain, The Netherlands, Austria, the UK, Israel, Germany, Portugal, France, Ireland, Belgium, and Japan.

The debt must be repaid: We must, of course, meet the “monthly payments,” but the level of debt need never be zero. The government has an infinite life span, so there is no day of reckoning when all debts must be settled. And since the debt is owed in dollars, there is never any question that we have the ability to repay since we are allowed to issue brand new ones at any time. Nor is this necessarily inflationary, as explained in the next fallacy.

Deficit spending could create inflation: Yes, it could, if we were already at full employment (unemployment around 4%). In that case, the government would be competing for resources in an economy where no excess existed–that might drive up prices. But we are a long, long way from that right now. Furthermore, inflation is a far more complex phenomenon than most people understand. For more on how inflation really works, see here:

Government surpluses help the economy grow: In fact, surpluses represent a net drain on private-sector income. Think about it: what would happen if the government spent zero but still collected taxes? That’s what a surplus is, an excess of tax revenues over government spending. We would be bleeding wealth from the private sector and giving it to the public sector. Economic growth creates government surpluses (because tax revenues rise and public support spending falls), not the other way around.

The US could default: Every penny of US debt is owed in a currency we are legally permitted to print. There is ZERO chance that we could be forced to default. We may choose to do so (just as a person in a room full of food could choose to starve), but that would be foolish. Note the strong contrast with Greece. They could, indeed, default, since they owe their debt in a currency they don’t control (there are, incidentally, many other reasons why the US and Greece are not analogous, but this one is key).

Quantitative Easing represented government deficit spending: These two are fundamentally different. Deficit spending creates new income by having the government pay for goods, services, and resources using the Treasury Department’s checkbook. Quantitative easing was meant change the form in which financial assets were held in the banking system so that it would easier for institutions to loan money. It created absolutely no new income whatsoever, which is why it was an utter waste of time. The problem was never that banks didn’t have money to loan. It was (and is) that everyone is too scared to borrow.

China controls our economy because we owe them so much money: It must be made clear that US debt to China has nothing to do with the federal government budget deficit and everything to do with the trade deficit. Even if the US government were in surplus, we would owe as much to China because our debt to them is simply the difference between how much we exported to them and how much we imported from them. They then take those excess earnings and use them to buy financial assets. That we had large budget deficits only served to make a particular financial asset–Treasury Bills–available to them in large quantities. We never needed China to buy these to finance the deficit because (in a roundabout fashion) we could always have monetized debt (i.e., sold the Treasury Bills to the Federal Reserve for brand new cash–see above for why this is not inflationary). The one thing we still don’t import from China are dollar bills! If they wanted all the money back tomorrow, we could just print it up and ship it over. China does not own the US, and they desperately need us to grow if they are going to make it because they have very little domestic demand to generate growth and are dangerously dependent on exports.

FURTHER RESOURCES

Explaining all this is so difficult because people already have in their heads that government budgets are analogous to their own. This is false, but it takes time and patience to explain why. Thus, while I hope you found the above interesting, you may want to read these, too. They represent more pointed and extended discussions of the issues we face.

This is the first piece I wrote here and is the most comprehensive treatment I have done:

I’d like to apologize in advance for the fact that I am simply not going to have the time to devote to answering comments that I usually do. I’ll do my best, but I have to start being more selective. I have too many other obligations, not least of all to my family! Speaking of which, I would also like to take this opportunity to publicly thank my wife, Melanie, for her help, encouragement, and patience with this project. She has read over many of these entries for me, pointing out where I was wrong and when I was unclear. Thanks, babe.

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Comments

You seemed to be motivated more by your politics and ideology than rationale economic thought in today’s specific economic environment.

“government spending doesn’t help the economy, and in fact is a drag: it pulls people away from productive work. The main causes of unemployment:”

First of all, unemployment sky-rocketed to 10%+ from 4-5% directly after the financial crisis. That had nothing to do with government spending and everything to do with a collapse in aggregate demand and the resulting recession.

“1) People get paid not to work. Long-term unemployment payments (and welfare) is a disaster. The government gets what it pays for: people not working.”

A “disaster” I do not know, but generally I can agree. To stop unemployment payments, these people need to be employed. So how about cutting taxes to stimulate aggregate demand, increase private sector spending, and generate the kind of employment we say only 3 years ago?

“2) Obamacare and fear of tax hikes (due to the large deficit) make employers nervous about hiring due to the expectation of increased benefit costs.”

That’s just a political talking point that holds hardly any water in an intellectually honest debate. Employers aren’t hiring because the economy sucks, and they see no demand for their products.

Again, the private-sector doesn’t see demand for their goods, so they have obviously cut back on investing. As for “foreign capital investment,” I am not sure what you are exactly referring to.

“4) A high minimum wage, which discourages hiring of unskilled workers who need to learn skills to obtain better jobs.”

Again, the unemployment rate sky-rocketed from 4-5% to 10%+ directly after the crisis. This was caused by the financial crisis. Fact. Again, this is more of your typical political talking points that completely ignores the specific situation at hand.

“5) Laws that prevent employers from hiring any willing worker, and apparently in the case of Boeing, preventing them from building new factories. There would be plenty of manufacturing jobs available if there weren’t union restrictions on productivity, continuous employment (strikes to make the union leadership seem important), benefits, and wages.”

Can’t speak directly to this, but this certainly isn’t the reason we are at 10% unemployment instead of 4-5%. These laws didn’t change when the crisis happened.

“Finally, there is not a finite number of jobs available: there is a shortage of competent people in software, some areas of healthcare, and many types of research and development, all of which could soak up a virtually unlimited number of people in productive activities that grow the economy. People would learn new skills to fill these positions if they had sufficient financial motivation to go to school and obtain the required skills. Software in particular is not terribly difficult to learn, as long as people are motivated and disciplined.”

Agree we need more people in these areas. But again, this is not a reason for today’s acute unemployment problem.

Totally disagree 100% (although it was interesting to read yet another pro-Keynesian article that I get to debunk):

1. Technically you are correct that we cannot default on our debt, but we can be forced to balance our budget if other countries stop buying up our debt, or face massive inflation if we don’t.

2. In your opening statements, you stated that education is a non-market service. Many people pay for education services. Just because the government has tried to monopolize education doesn’t mean there’s not a private market for it.

3. Also in your opening statement, you stated “a modern capitalist economy without public sector demand will fail.” So adequate demand is only created by the public sector? The private sector creates demand by producing a product or service that is determined to have value at or above that in which it costs. Government activity or even the existence of government is not required to accomplish this. People trade products and services all the time – money just makes transactions easier. When people realize that the value of currency changes rapidly, they largely forgo using currency and instead focus on trading. When people go through hard times and government is not there to help, they must either rely on others to help them (i.e. charity or family), or must figure out other ways to meet their basic needs. This includes begging, working for food and shelter, and stealing, or even becoming innovative (i.e. figuring out a new way to solve a problem, or inventing a new product or service that is determined to be of value to a consumer), which can be the most productive. The reason that long-term welfare fails, as your article unsuccessfully tries to debunk, is that it destroys the will of the individual to work, just as socialism does.

4. Surely you can spend your way out of recession, but at what cost? For subpoint #1, refer to my first point about default. Also, much of our consumption is foreign products, be it oil or cheap electronics. How does that help our economy? And what side effects does this manufactured demand have? Just because someone could buy 10 brand new cars or 100 plasma TVs does not mean they will, and what does that do to commodity prices and the environment?

5. Your first popular fallacy, “When the government spends in deficit, that means I am being taxed more” is in fact not a fallacy at all, assuming that my first point comes true.

6. You also said “Nor is there some web of regulations and taxes that is preventing recovery.” Are you joking? Have you seen our tax code? How about the healthcare or financial reform bills? Hundreds of thousands of pages are being added to the federal register every year, making life more and more difficult for small businesses by raising compliance and operating costs. If you weren’t aware of this fact, I honestly question Forbes’ choice of editorial writers.

Why won’t the Democrats explain this? Everyone seems content to say households can’t live beyond their budgets, as if Keynes had never lived. And besides, households regularly live beyond their income for education borrowing, mortgages and loans to start a business. Cutting taxes sends a huge chunk of money out of the country for TVs, BMW sedans and all sorts of things we don’t make here. Borrowing at near zero interest rates to rebuild the country from highways to airline GPS guidance systems makes sense and some of it, like updating the air traffic control, has very fast payback.

In reality though, if we are ever to increase the deficit, it’s most realistic for us to do it through tax cuts rather than spending increases. The deficit increases just the same, and aggregate demand should be boosted. The merits of govt spending vs tax cuts can be debated, but I’m just talking realistically here. But you are right- the Dems are clueless just the same.

Is this guy a parodist? A Washington DC comedian. Yeah some truth here, along with every hackneyed leftist disproved pedant’s dream. Educate the public, how sweet- a classic. Jobs for police and soldiers? Govt “investment” is best and doesn’t destroy private iniatitive? We spent our way out of the Great Depression? Why don’t we just eliminate the private sector,start a few more wars and establish a police state, the economy will be roaring along in no time.

No, but apparently you can only think in black and white extremes. The author clearly didn’t suggest anything along the lines of what you did, but you morph it into that to fit your blind ideology biases. He is not necessarily asking for “more government.” The point is not to decrease the deficit given today’s SPECIFIC CIRCUMSTANCES. If you don’t like government spending, then cut taxes. The point is to raise aggregate demand, increase employment, and get the economy back to full capacity. Once that happens, the deficit should and automatically will come down as tax revenues increase, welfare and unemployment benefits go down, and stimulus measures expire. Try to think for yourself a little rather than reciting the same, tired political catch phrases you’ve been fed all your life.

So, once again, the “smart” solution is to replace what was once the province of family, friends and personal discipline – systematic savings to carry us through the troughs of economic cycles; continuous self improvement to maintain our marketability despite the vagaries of a hyper-dynamic market; loved ones to lend a temporary hand when all else fails – with the least efficient organization yet conceived, our federal government. And all we’ve got to do is print or borrow even more today to repay what was borrowed yesterday because there is no day of reckoning in the macro world of a perpetually nonproductive U.S. federal government? Yeah, that’ll work!